When to Refinance a Mortgage

Published: October 13, 2017

Contrary to what you may think, signing up for a mortgage loan does not mean you’re trapped in that rate or term. If rates change or events arise that prevent you from paying as you had planned, refinancing might be an effective way to change your monthly mortgage payment.

Refinancing means paying off your existing mortgage with a new one, potentially with a lower rate or monthly payment. However, refinancing also typically involves costs such as appraisal and loan origination fees, which can add up to as much as 3% to 6% of the amount you are refinancing. The following scenarios are ones in which refinancing could be worth considering.

Your Credit has Improved

If you received your mortgage at a time when you had average credit or a short credit history and your score has since improved, you may qualify for a lower rate now. If so, you may be able to pay off the principal faster and more quickly build equity, or the difference between your home’s appraised market value and what you owe on it.

Interest Rates Drop

The market may have changed since you got your mortgage. Many experts recommend refinancing if you can get a rate that’s at least one percentage point lower than your current rate. This can mean saving tens of thousands of dollars in interest costs overall if your current principal balance is large.

You Want to Consolidate Other Loans

With cash-out mortgage refinancing, you take out a loan for more than what you owe on the home. For example, say your home is worth $400,000 and you still owe $150,000. You could take out a new mortgage for $200,000, with $50,000 coming to you in cash. This can be handy if you’d like to consolidate any high-interest debts, such as student loans, credit card balances or auto loans. When you take cash out this way, though, you reduce your home equity.

You Want to Switch from an Adjustable to a Fixed-Rate Loan

If you have an adjustable-rate mortgage, or ARM, you run the risk of the payments increasing, which can be hard to handle long-term if you have a level income. Refinancing may enable you to switch to a fixed-rate loan and take the uncertainty out of your mortgage payment plan, which is especially beneficial if you think rates will increase over time.

You Want to Change your Monthly Payment

You may be able to extend your mortgage term to reduce your monthly payment if your current one is not affordable anymore. On the other side, you may also shorten the term, such as getting a 15-year to replace your 30-year loan. This would raise your payments but also let you pay off the debt more quickly.

When Not to Refinance

Although refinancing has its advantages, it’s not for everyone. Bear in mind that if any of the following apply, it may not be a good idea.

You’ve had your mortgage a long time. For most 30-year mortgages, you pay most of the interest in the first two decades of the loan. After that, more of your payments go to reducing the principal balance than paying interest, so refinancing would probably mean spending much more on interest than you would if you kept your current loan, even if the rate is high.
Your mortgage has a prepayment penalty. Your lender may charge you for paying off the loan too early. A penalty fee can range from one to six months’ worth of interest payments, and that is in addition to the other costs of refinancing.
You plan to move soon. Refinancing can help save you money in the long term. If you plan to leave your home in the next few years, you might not reach the break-even point when the monthly savings on payments surpass the upfront refinancing costs.
In certain situations, refinancing is a productive strategy. If it is early in your mortgage, you need to pay off other high-interest debt or you can improve upon the terms of your current loan, refinancing could be a money-saving move.

Senate Cents: A Financial Wellness Blog